How COVID-19 is changing the landlord-tenant relationship

The crisis has thrust businesses into commercial discussions with long-term implications

May 14, 2020

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Widespread economic shutdowns have forced many business owners into challenging conversations with their landlords, with the outcomes poised to change the commercial real estate landscape.

Pandemic clauses are not a standard feature in most commercial lease agreements and, with precedent lacking, landlords and tenants have found themselves in unchartered waters as they negotiate voluntary arrangements such as rental abatements or waivers.

The lessons learned from the current crisis are likely to change the terms of future leases and shift the dynamics of real estate’s “most important partnership”, says Richard Fennell, head of property and asset management – Australia, JLL.

“Landlord-tenant relationships last a long time,” he says. “They are worked on and continually managed. While neither side is at fault in this unique situation, perhaps parts of the system are – certainly the adversity is teaching us some valuable things.”

As coronavirus lockdowns cause cash flow problems for businesses, property owners are also facing shortfalls in income. Some of the biggest shopping centre owners globally have only been able to collect 20 percent to 40 percent of their total rent since lockdowns began, according to company reporting. As a result, some shopping centre owners are making lower loan repayments and will potentially breach loan covenants.

In Australia, as well as in the UK, the current environment is opening up discussions more broadly on the inclusion of turnover rents where all, or a proportion, of rent is based on the gross income generated by the tenant at the premises – a common practice in Australia’s regional shopping centres, and factory outlets in the UK.

Premier Retail, one of the largest retailers in Australia, is said to have decreed that its 1,200 stores will no longer pay a fixed amount of rent, but rather a percentage of gross sales.

Along similar lines, department store Myer is reported to be negotiating lease payments equivalent to 6 percent of sales.

“Turnover rents help further align the interests of landlords and tenants so that each can proportionately share the peaks and troughs of the broader economy,” says Cameron Taudevin, director, retail leasing Australia, JLL.

The pandemic has compounded existing challenges faced by a retail sector already struggling with the competition of e-commerce, softening asset values, and the business model of some retailers is being challenged.

“The recent shake up will bring landlords and tenants to the table to revisit the terms of their leases and find a structure that will give landlords greater certainty of tenure and cash flow in exchange for sustainable rental structures with sufficient working capital relief up front,” Taudevin says.

Changing lease requirements

Within the legal systems of Australia, the U.S., Hong Kong and Singapore, unless contracts explicitly describe an epidemic or pandemic as a possible ‘force majeure’ event, there is generally no obligation on the landlord to provide any rent concession.

“Lease terms may be very different going forward,” she says. “We would expect changes in rent, the term of a lease and perhaps the level of security required by a landlord under the lease. Likewise, at least in the immediate future, we also expect there will be more scrutiny over legal drafting to specifically deal with rent abatement or rent deferrals – or the specific exclusion of such rights – in the case of a crisis of this nature.”

While real estate industry representatives agree that property companies must be flexible on rent and support distressed industries, there is concern around the potential “over-handling” of leases.

“The vast majority of properties that tenants occupy are owned by superannuation funds and other vehicles that comprise of many Australians’ savings and pensions, so we have to be really careful when building in break clauses and termination rights to leases,” says JLL’s Fennell. “We don’t want to discourage investors from that as it will hold us all back economically. Parties need to work collaboratively, and with a customer mindset, to allow businesses to flourish, and assets to grow in value.”

Increased co-operation

Meanwhile, a renewed focus on co-operation will be paramount to ensure buildings are safe and accessible to workers when they return to work.

Good relations will also pay off commercially, says Michael Greene, head of tenant representation, Australia, JLL, attesting to “fruitful” conversations where tenants can prove genuine hardship, and low tolerance for those less honest.

“The biggest test will come when tenants want to renegotiate lease benefits. The extent to which tenants and landlords will be willing to work on viable long-term relationships will very much depend on the conversations happening now,” says Greene. “Being stubborn to the detriment of the other will benefit no-one.

“Lessons should be learned from the retail sector, and rather than holding on to an outdated leasing model, landlords and tenants will need to be flexible and creative in dealing with the challenges. Failure to embrace this will only lead to business failures on both sides of the equation,” Greene says.